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TMI Blog2014 (11) TMI 102X X X X Extracts X X X X X X X X Extracts X X X X ..... reason to believe that there has been an escapement of income by the Id. Assessing Officer the reopening is bad in law. 3. That there was no reason to believe as contemplated under section 147 of the Income Tax Act, 1961 that income chargeable to tax had escaped assessment and hence the assessment as framed by the Id. Assessing Officer is not valid in law and deserves to be quashed. 4. That the reasons alleged to have been recorded are not based on facts but on suspicion which cannot be the foundation for formation of reason to believe as contemplated under the provisions of section 147 of the Income Tax Act, 1961 and hence the reopening is bad in law and reassessment as framed deserves to be quashed. 5. The Id CIT (Appeals) had erred in holding that the Assessing Officer had validly invoked and had rightly assumed the jurisdiction under section 147 of the Income Tax Act, 1961. 6. That in the absence of any PE in India in terms of DTAA (Double Taxation Avoidance Agreement), no profits alleged to have accrued to the appellant are there and consequently the levy of tax as made by the AO is arbitrary, unjust and bad in law. 7. That the appellant functions as a Branch of the US N ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ence of any PE in India in terms of DTAA (Double Taxation Avoidance Agreement), no profits alleged to have accrued to the appellant are there and consequently the levy of tax as made by the AO is arbitrary, unjust and bad in law. 2. That the appellant functions as a Branch of the US Nonresident involving only in preparatory and auxiliary activities for US Nonresident the cost whereof is reimbursed by US hence there could be no income accrued to the appellant and consequently the assumption of income at Rs. 23,89,345/ - is arbitrary, unjust and bad in law. 3. That in the absence of any income embedded in the amount reimbursed by US Nonresident to its Branch (appellant), acting as a pure a cost centre the assessment at a Rs. 23,89 ,345 / - is bad in law. 4. That there is no international transaction with an Associated Enterprise (AE) contemplated under Section 92C of the Income Tax Act, 1961 hence no income ought to have been deemed under Section 92C of the Income Tax Act, 1961. 5. That the provisions of Section 92C in terms are not applicable and consequently the assessment made at Rs. 23,89,345/ - as made by the AO is arbitrary, unjust and at any rate very excessive. 6. Withou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the earlier return may be considered to be return filed in response to notice u/s 148 of the Act. The AO rejected the objection of the assessee towards reopening of assessment u/s 147 and 148 of the Act and made an addition of Rs. 15,39,789 towards Arms' Length Price (ALP) reimbursement of Indian branch. The aggrieved assessee preferred an appeal before the CIT(A) mainly on two grounds, first, challenging the reopening of assessment u/s 147 and 148 of the Act and, secondly, challenging the addition made by the AO on account of cost +8.5% reimbursement of total expenditure of Indian Branch. 4. Ld. CIT(A) decided the appeal of the assessee for AY 2003-04 by passing the impugned order dated 10.12.2008 and held that the AO has rightly assumed jurisdiction u/s 147 and 148 of the Act on legal grounds and contention of the assessee towards reopening of assessment was rejected. 5. From the record of ITA 1597/Del/2009 for AY 2003-04 and ITA 1598/Del/2009 for AY 2004-05 of the assessee, we observe that the AO made similar kind of addition in both the years by holding that the total expenditure incurred as per audited expenditure and income account requires to be computed by adding mark up ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quashed. Ld. Counsel of the assessee also contended that the impugned reasons alleged to have been recorded are not based on fact but on suspicion which cannot be the foundation for formation of reason to believe as contemplated under the provisions of section 147 of the Income Tax Act, 1961 and hence the reopening is bad in law and reassessment as framed deserves to be quashed. Ld. Counsel pointed out that the ld. CIT (Appeals) grossly erred in holding that the Assessing Officer had validly invoked and had rightly assumed the jurisdiction under section 147 of the Act for issuance of notice u/s 148 of the Act. Ld. Counsel reiterated its argument before the authorities below and submitted that the reopening of assessment may be quashed under the facts and circumstances of the case. 9. Replying to the above, ld. DR submitted that at the time of initiating proceedings u/s 147 and 148 of the Act, the AO is not expected to reach a final conclusion regarding the taxability of such income under the Act, only a prima facie belief regarding escapement of income would be sufficient for invoking the provisions of section 147 of the Act. A reference can be made to the decision of Hon'ble Supr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng escapement of income would be sufficient for invoking the provisions of section 147 of the Act. A reference can be made to the following two decisions of Supreme Court which make it clear that merely a prima facie belief with respect to escapement of income has to be found - (i) It has been laid down by SC in case of Raymond Woollen Mills (1999) 236 ITR 34 that where there is a prima facie material, the sufficiency and correctness of the belief cannot be questioned at this stage. At this stage, the final outcome of proceedings is not relevant. In other words, at the initiation stage, what is required is reason to believe, and not the established fact or computation of income. Whether the material would conclusively prove the escapement is not the concern at this stage. It may be seen that AO has referred to the findings of the A.Y. 2002-03 in the reasons. This clearly indicates the facts and application of laws which has gone into forming his reason to belief. It has nowhere been denied that the appellant was not carrying out the activities during the years under consideration (i.e. the years of which notice u/s 147 has been issued). Similar views have been expressed in the cas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pex Court in the case of Raymond Woollen (supra) wherein it was held that where there is a prima facie material, the sufficiency and correctness of the belief cannot be questioned at this primary stage. The final outcome of the proceedings are also not relevant at this stage. Their lordships further clarified that at the time of initiation stage what is required is reason to believe and not the established fact or computation of income which escaped assessment. In the case of ITO vs Selected Co. Ltd. (supra), their lordships also held that formation of belief is within the realm of subjective satisfaction of the AO. Under these circumstances, we are inclined to hold that the action of the AO was proper and in conformity with the provisions of the Act as well as ratios evolved as a result of court and Tribunal decisions on this issue. Accordingly, legal contention and ground of the assessee in ground no. 1 to 5 being devoid of merit deserve to be dismissed and we dismiss the same. Ground no. 6 to 10 in ITA No. 1597/Del/2009 and ground no. 1 to 5 in ITA No. 1598/Del/2009 13. The assessee has also raised additional grounds before the CIT(A) by alleging that there is no PE in India in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... paratory activities are distinguishable on facts and the ratio does not apply to the facts of the case. In view of the facts of the case, the assessee has PE in India under the provisions of paragraph 1 and 2 of Article 5 of the treaty." 15. Replying to the above, ld. Counsel of the assessee has drawn our attention towards written synopsis and submitted additional argument as rejoinder to the issue. From para 10 at page 3, we observe that the main contention of the assessee on the issue of PE reads as under:- "10. Before the Commissioner of Income Tax (Appeals), the assessee raised the grounds that for the purposes of taxation of business profits of a foreign entity in India, there must be a PE and the existence thereof is a pre-condition for taxation purposes. The PE has to be considered in accordance with the Double Taxation Avoidance Agreement (DTAA) with US. The PE has been defined in Article 5 of the DTAA and it includes a branch, but paragraph 3 of Article 5, which is an exclusionary provision, states in clause (e) that the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for other acti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any income has been shown and declared in the income-tax return, the assessee may resile from the position because the income has to be assessed in accordance with the provisions of law and not on the basis of admission of an assessee." 17. On careful consideration of above submissions on the issue of PE and careful perusal of the relevant operative part of the impugned order, we observe that the assessee is agitating the issue with the contention that the PE has been defined in Article 5 of the DTAA between India and US which includes branch but para 3 of Article 5 which is exclusionary provision states in clause (e) that the maintenance of stock of goods, fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise shall not be deemed to be the PE as contemplated under Article 5 of DTAA because the Indian Branch is only engaged in the supporting service to the US Head office. It is also contended that the services and activities of the assessee entity are in the nature of preparatory and auxiliary services, hence, no income can be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed 29.04.2008 that the India Branch office during the relevant point of time was primarily engaged in back end jobs and working under total control, superintendence and direction of the Head office in USA. It was further confirmed that in absence of any jobs to the Indian branch office, its workers and supervisory staff on the bench doing R&D was not resulting in any productive work. In view of above factual matrix about the working and activity of the Indian branch office, and its role towards US Head office, clearly show that Indian branch office during the relevant period carried out engineering, calculations as well as drawing of various architectural designs for the US office. 21. Admittedly, the assessee entity branch office was also doing R&D work for the US Head office and the same was being done exclusively by the Indian branch which was the core business of the assessee and we decline to accept the contention of the assessee that such a work was of preparatory or auxiliary character within the ambit of Article 5(3)(e) of the Indo US treaty. In the case of Morgan Stanely and Co. Inc. (supra) the Hon'ble Apex Court in the peculiar facts and circumstances of the case observ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons proposed to be performed by MSAS in India falls under Article 5(3) (e) of the DTAA. Therefore, in our view in the present case MSAS would not constitute a fixed place P.E. under Article 5(1) of the DTAA as regards its back office operations. However, the question which arises for determination in the present case is the nature of activities performed by stewards and deputationists deployed by MSCo to work in India as employees of MSAS. Under Article 5(2)(l) furnishing of services through the fixed place in India can constitute a P.E. The AAR in the impugned ruling has held that the stewards and deputationists are proposed to be sent by the MSCo from U.S. According to the AAR there is a flow of service from the MSCo to the MSAS when the former deputes its own employees to work in India in MSAS. Therefore, according to the AAR the service Agreement between MSCo and MSAS dated 14.4.2005 would fall under Article 5(2)(l) and consequently the transfer pricing regulation would apply for evaluating the charges payable by MSCo to MSAS in India for such service contract. This ruling has been challenged by the applicant." 23. Thus, we respectfully hold that the case laws cited and relied ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The ld. DR strongly supported the assessment order and submitted that the AO calculated attributable profit at 100% of the figure arrived at after applying the profit rate of 8.5% for AY 2003-04 and 10.6% for AY 2004-05 according to the global profit ratio of the assessee. The ld. DR also submitted that the calendar year 2002 for AY 2003-04 and calendar year 2003 for AY 2004-05 cannot be said to be a suitable bench mark for adopting global profit rate because financial year for AY 2003-04 goes up to 31.3.2003 and financial year for AY 2004-05 goes up to 31.3.2004. 26. On careful consideration of above contentions, at the outset, from bare reading of the impugned order, we observe that this issue has been decided against the assessee by the CIT(A) with following observations in AY 2003- 04:- "From the above it can be seen that rule 10 has to be applied in accordance with para 2 of the article 7 accounting thereby that only the profits which are attributable to the PE can be taxed in India. Application of global profit rate to the Indian turn over results in the profit of the enterprise relatable to Indian operations. However this has to be attributed to the PE on the basis of risk ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ection to be treated as sole corporate will not affect the application of the provisions of Indian Income-tax Act and, therefore, the appellant has to be treated as a company for the purpose of status. The AO has accordingly correctly applied and determined the status of the appellant as a foreign company, therefore, ground of appeal no. 7 is dismissed." 27. On careful consideration of above submissions, we note that from earlier part of this order, we have upheld the findings of the authorities below that the assessee has PE in India as per provisions of Article 5 (2)(b)(c) of Indo US DTAA. Coming to the issue of attribution of profits to PE in India, from page no. 191 to 209 of the Paper Book, which contains transfer pricing analysis report, the assessee itself has adopted the mark up to the cost at 1.83% and at the same time, the AO found that the net profit earned by the Head Office of the assessee in US tax return was 8.5% which was based on sales. The revenue authorities have observed that the assessee has not submitted record of uncontrolled transactions and the record of analysis, how the uncontrolled transactions are comparable to the case of the assessee as per requireme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... CIT(A) has to take into account this very fact that the actual income returned was before the US revenue department. Ld. Counsel pointed out that for the AY 2003-04, the CIT(A) had taken into consideration the vertical balance sheet whereas for AY 2004-05, the CIT(A) had taken into account the income tax return filed by the assessee in India. Ld. Counsel also submitted that as per section 92 of the Act, the ALP in relation to an international transaction shall be determined by one of the most appropriate method prescribed therein having regard to the nature of transaction or function performed. Ld. Counsel further contended that Rule 10B has further explained the procedure for determination of ALP under various methods prescribed u/s 92C of the Act. Ld. Counsel further submitted that the CIT(A) applied the profit split method as explained in Part B of Sub-rule (1) of Rule 10B of the Income Tax Rules 1962. Ld. Counsel has drawn our attention that first of all, the combined net profit of the AE arising from the international transaction in which they are engaged will be determined and then the relative contribution made by each of the AE towards the earning of such combined net prof ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method, attribution of profit to Indian PE based on expenses incurred in India amounts to use of profit split method taking the cost incurred in two tax jurisdiction as a key split in the profit. The ld. DR also contended that the CIT(A) ignored liberal approach of the AO wherein the AO has considered the actual figures of cost incurred and did not take into account the cost of these services if rendered in US and on this account, the AO had not made any adjustment due to locational savings and the AO has attributed profits to the Indian entity on a very lower side, therefore, the CIT(A) has no justification for further reducing the profits of Indian PE by 50%. The ld. DR further submitted that once profits are attributed to Indian operations based on Rule 10 of Income Tax Rules 1962 as done by the AO, then there is no scope of attributing a part of this profit to US Head office. The ld. DR also pointed out that the CIT(A) has failed to appreciate that the profits earned by the assessee have already been allocated to the Head office and Indian PE based on mark up to cost incurred by them and there cannot be further attribution as all the development activities have taken place in I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contentions of the assessee for wrong adoption of global profit of the US Head office are not sustainable. At the same time, we also observe that the CIT(A) was reasonable and justified in directing the AO to calculate the attributable profit at 50% of the figure arrived by the AO after applying global profit rate of US Head office for the respective assessment years under consideration in these appeals. Accordingly, ground no. 11 & 12 for AY 2003-04 and ground no. 6 & 7 for AY 2004-05 of the assessee as well as ground no. 1 to 4 of the revenue in both the appeals for AY 2003-04 and 2004-05 are dismissed. Ground no. 13 of the assessee for AY 2003-04 and gorund no. 8 of the assessee for AY 2004-05 35. Ld. Counsel for the assessee submitted that the revenue authorities ought to have adopted the status of the assessee as individual independent foreign company because the CEC is a firm and not a company even in the US as it is 100% owned by a single individual and, hence, does not fall in the category of a company. Ld. Counsel for the assessee further contended that the authorities below ought to have adopted the status of the appellant as individual instead of foreign company becau ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rinciple from this clarification given in the treaty, it is clear that an election to be treated as sole corporate will not affect the application of the provisions of Indian Income-tax Act and, therefore, the appellant has to be treated as a company for the purpose of status. The AO has accordingly correctly applied and determined the status of the appellant as a foreign company, therefore, ground of appeal no. 1 is dismissed. " 38. In view of above conclusion of the CIT(A), we observe that in the ground itself, the assessee has mentioned that US Head office is a firm and not a company even in the US tax status, therefore, the assessee should be given the status of individual instead of foreign company. We further observe that the CIT(A) has rightly concluded that while applying or determining the status of the appellant, the provisions of Income-tax Act have to be applied. As per provisions of Income- Tax Act, anybody corporate incorporated by or under the laws of any country outside India has to be treated as a company. Therefore, we hold that the assessee was rightly treated as a foreign company for the purpose of tax status and the AO correctly applied and determined the stat ..... X X X X Extracts X X X X X X X X Extracts X X X X
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